Su­nak’s time bomb

The Chan­cel­lor is right to spend money now – but there will be painful con­se­quences Roger Boo­tle

The Daily Telegraph - Business - - Front Page - roger boo­tle Roger Boo­tle is chair­man of Cap­i­tal Eco­nomics

Last week the Chan­cel­lor had his spend­ing boots on. While the re­sponse to his raft of mea­sures was gen­er­ally very pos­i­tive, there were two quite dif­fer­ent cri­tiques. One was to crit­i­cise him for not giv­ing away enough and for time-lim­it­ing key el­e­ments, thereby set­ting up the pos­si­bil­ity of a cliff edge for the econ­omy when these con­ces­sions end.

The sec­ond line of crit­i­cism con­cerned the usual anx­i­ety about where all the money is com­ing from. We will get a clearer per­spec­tive to­mor­row, when the Of­fice for Bud­get Re­spon­si­bil­ity (OBR) de­liv­ers its Fis­cal Sus­tain­abil­ity Re­port.

Those who com­plain about the inad­e­quacy of the Chan­cel­lor’s pack­age must be liv­ing on an­other planet. It cost £30bn, amount­ing to 1.4pc of GDP. Com­ing on top of ear­lier re­lief mea­sures cost­ing about 7pc of GDP, this means that, pro­por­tion­ately, the UK is giv­ing a larger amount of fis­cal sup­port than Ger­many and Ja­pan, and about the same as Amer­ica. Com­bined with the ef­fects of eco­nomic weak­ness, it will take this year’s gov­ern­ment bud­get deficit to al­most 20pc of GDP.

For the UK, this is by some dis­tance the high­est peace­time bor­row­ing ever. It is not far off the to­tal debt of 26.8pc of GDP recorded in 2001 and 2002. In one year! It will take the debt ra­tio to about 105pc of GDP. What’s more, the Chan­cel­lor made it clear that in the Bud­get and Spend­ing Re­view, due later this year, there would be more in­vest­ment in pub­lic ser­vices, in­fra­struc­ture and the re­gions. So far, aus­ter­ity hasn’t had a look in.

Should we be wor­ried? Eco­nomics is a tricky sub­ject. It is not con­cep­tu­ally dif­fi­cult but it in­volves a web of con­flict­ing re­la­tion­ships and con­flict­ing val­ues. Things are never com­pletely straight­for­ward. Ac­cord­ingly, eco­nomic pol­icy de­mands the ex­er­cise of judg­ment.

Is it right for the Chan­cel­lor to be dish­ing out so much money, caus­ing bor­row­ing to sky­rocket? I think the an­swer is yes. Will there po­ten­tially be painful con­se­quences from such largesse? I think the an­swer is also yes. That is why, even in this Alice in

Won­der­land world where money gets squirted around like cham­pagne at a For­mula 1 cel­e­bra­tion, the Chan­cel­lor still has to try to get the best value for what he spends. It is only in the fairy-tale world be­lieved in by some ad­her­ents of Mod­ern Mon­e­tary The­ory (MMT) that he can spend with­out fear of the con­se­quences.

And it is also why in­tro­duc­ing time lim­its for his var­i­ous sup­port mea­sures is a good idea. For a start, this max­imises the chance of a rel­a­tively large ef­fect in the near term as peo­ple bring for­ward ac­tiv­ity into the com­ing months. It also means that the scale of the fis­cal sup­port for the econ­omy is due to fall back later, when, it is hoped, the econ­omy should be stronger.

This also sup­ports the tar­geted na­ture of the mea­sures, with money go­ing to the sec­tors hard­est hit, in­clud­ing the hospitalit­y in­dus­try and the hous­ing mar­ket. But this too in­volves a balanc­ing act. On the one hand, the over­all econ­omy will prob­a­bly be stronger the more that dev­as­tated ar­eas of eco­nomic ac­tiv­ity are pre­served.

On the other hand, the Gov­ern­ment shouldn’t be in the busi­ness of pick­ing win­ners – and that in­cludes pick­ing survivors. The forces un­leashed by this pan­demic will prob­a­bly have a last­ing ef­fect on the struc­ture of the econ­omy and it is im­por­tant for fu­ture pro­duc­tiv­ity and pros­per­ity that the new struc­ture, which can­not be ex­actly fore­seen by any­body, has a chance to un­fold of its own ac­cord. This ar­gues against try­ing to pre­serve in as­pic the eco­nomic struc­ture that ex­isted be­fore.

So what will the OBR say this week? Is the high debt ra­tio sus­tain­able? I am pretty sure that the an­swer it gives will amount to “yes … but”. Al­though much in­creased debt is un­wel­come, it is not, in it­self, disas­trous. Coun­tries have some­times op­er­ated suc­cess­fully with even higher debt – in­clud­ing our­selves for much of the last 200 years.

More­over, the cur­rent cost of fi­nanc­ing this debt is ex­tremely low. Ten-year gilt yields are only 0.16pc. Mean­while, on the debt that is bought by the Bank of Eng­land, the cost is even lower. It is Bank Rate, cur­rently 0.1pc, which is paid to the com­mer­cial banks on their de­posit hold­ings at the Bank that fi­nance its hold­ing of gilts, ac­cu­mu­lated through the pol­icy of quan­ti­ta­tive eas­ing (QE). And it is likely that mar­ket in­ter­est rates will stay pretty low for some con­sid­er­able pe­riod.

The “but” de­rives from the risk that things will not re­main this ac­com­mo­dat­ing – as they surely won’t for­ever. Sup­pose that mar­ket in­ter­est rates rise sig­nif­i­cantly. OK, the Gov­ern­ment could sim­ply opt to carry on sell­ing gilts to the Bank of Eng­land, pro­vided that the Bank agrees, which it is not bound to do. But even if it does, when it even­tu­ally raises Bank Rate, to nor­malise the econ­omy and head off in­fla­tion, this would in­crease the Gov­ern­ment’s fund­ing costs.

And the sup­ply of bank re­serves, as well as broad money, would con­tinue to ex­pand rapidly, thereby in­creas­ing the in­fla­tion­ary dan­ger. The way to stop this would be for the Bank to sell gilts to the mar­ket, i.e. re­vers­ing QE. But this would drive up their yields, and thereby in­crease the Gov­ern­ment’s fund­ing costs. So, when the au­thor­i­ties wish to de­ploy poli­cies to stop in­fla­tion, the real cost of the cur­rent largesse will start to be­come clear. The chick­ens will then come home to roost.

It would be nice to be­lieve that some­how such nasty trade-offs can be avoided. They can be post­poned and they can be fi­nessed at the mar­gin through good pol­icy and care­ful man­age­ment. But in the end they will come back to bite us.

So I ex­pect the OBR to give an as­sess­ment to­mor­row that im­plic­itly lends sup­port to the Gov­ern­ment’s strat­egy but that also is­sues a warn­ing. In my view, it will be right on both counts.

Rishi Su­nak, the Chan­cel­lor, meets an em­ployee dur­ing a visit to the Worcester Bosch fac­tory in the West Mid­lands

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